What is the difference between borrowing in DeFi?

Tram Ho

If you are interested in finance, you may have heard more or less crypto lending – a new trend that is attracting billions of dollars and opening up new opportunities for investors.
So this article will explain the question: Is crypto lending different from normal borrowing that attracts so much attention?

At the time of writing, the amount poured into crypto lending is $ 3.72B, refer to defipulse .


1. What is crypto lending?

At its core, crypto lending is a fairly simple concept: The borrower uses electronic money as collateral to get a fiat loan (or another electronic currency) and the other person responds to the loan. loan at an negotiated interest rate. This could also work in a different way, when borrowers use fiat money as collateral to borrow a cryptocurrency.

You may find that nothing breakthroughs here – they are simply mortgage loans, but opening up new monetization opportunities for investors in the burgeoning DeFi ecosystem. . With DeFi, access to loans is no longer required through KYC , and new ways to make money are gradually emerging such as: deviation exchange, margin trading, flash loan, …

2. How important is Lending to the market?

Basically, credit and borrowing markets increase the amount of money for manufacturing jobs by distributing money from those who do not have a need to use it to those in need. As a result, both parties benefit, allowing the borrower to access capital and the lender to make a profit.

The advent of crypto lending offers a great opportunity for the crypto market and users, traditionally having only two options: hold or trade cryptocurrency. New ways to profit with crypto lending have emerged. Crypto lenders can receive a higher interest rate (~ 8%) than US savings (~ 1%). And the borrower makes a profit by using that money for trading, trading for exchange rate differences, market-making, or avoiding taxes by trading with electronic money, …

While this is a huge improvement to the crypto ecosystem, it doesn’t bring credit to its strengths – as of now, all crypto loans are overly “mortgaged”, This means that you must have capital available to be able to borrow.

3. Two lending platforms: Centralized and decentralized

Since 2018, lending platforms have proliferated in the crypto industry with many different models but in essence, can be divided into 2 groups: centralized and decentralized. The core difference is: who / what is handling the borrowing process?a business or protocol .

Centralized lending platforms work just like traditional fintech companies – they follow KYC ‘s processes, have custodial systems to protect their assets, and can form business partnerships. negotiate specific loan agreements). These platforms tend to offer predetermined interest rates, and often offer a higher return on lender when compared to decentralized platforms.

Decentralized lending platforms, such as Compound, Maker, and dYdX, work as protocols that can be accessed by anyone and at any time without KYC or oversight (except Maker , has a decentralized management system to determine interest rates). These platforms have variable interest rates based on the supply / demand (for an asset) and the formula for calculating the interest rate.

Fact: This can sometimes lead to large rate swings, with dYdX spiking over 30% at times.

4. What are the risks of crypto lending?

Although crypto lending is often compared to traditional lending models in many ways, admittedly this is a newer and risky model because loan management is not good.

  1. First, borrowers have to bear the available risk that the value of their collateral may drop below its required value (the amount that ensures that the lender always receives interest), leading to they are liquidated.
  2. In the Defi ecosystem, smart contracts are considered law, so each bug when programming can be exploited to attack the lending platform.
  3. Liquidity problems (eg, large amounts of money are poured in or withdrawn) can cause volatility in lending rates. Although the interest rate functions are designed to withstand this big change, it is not certain that they will not happen.
  4. Finally, crypto lending may be subject to regulations, taxes, KYC policies, … and so far, many regions have not had regulations on the use of electronic money (even stablecoins).

New technologies and protocols are constantly being born, promising to soon fill risks and make crypto lending (or more broadly, DeFi) more desirable than ever !!!

5. Usecases of crypto lending

Perhaps the best way to understand how these platforms and markets work is through the ways in which we can get in, from the mainstream to the advanced.

5.1. Borrowing and borrowing electronic money

Naturally, this is the most fundamental area of ​​crypto lending. Currently, many platforms are offering this service at different interest rates.

CoinMarketCap can refer to the interest rates of many different crypto lending platforms.

5.2. Increase liquidity and avoid taxes

For holders, cryptocurrency is a part of their wealth. Under the policy of many places, selling this property can result in income tax. So in case of needing cash (in the short term), the holder can completely replace the electronic money (will incur taxes and lose investment opportunities), but choose another way to mortgage this property for a loan amount.

5.3. Rate arbitrage – Exchange of price difference

If you have visited CoinMarketCap , you will recognize an opportunity to monetize the interest rate differential between platforms. For example, at the time of writing, you can borrow ETH on Aave at 0.55% interest and loan on Crypto.com with 6.0% to get an ETH return of 5.45% (annual average ). However, this way of making money requires a lot of experience because once Aave and Crypto.com change their rates, you can lose money.

5.4. Margin trading / leverage

The increase in crypto lending has also led to easier margin trading, no longer having to go through centralized exchanges. Users can take out a loan, buy more collateral and increase their loan amount in a loop until the limit is reached. This is the same as the “long term” investment in chosen collateral.

For example, if I use ETH as collateral to borrow DAI and then sell DAI to borrow more ETH and ETH price increases, I still only have to repay the original money – even though ETH has increased in value. This allows me to make more profit. Platforms like dYdX make this simple, allowing you to buy or sell with leverage up to 5 times. But it is obviously risky if the ETH price goes down, your collateral could be liquidated (to protect the lender).

5.5. Flash Loan – Quick Loans

Flash loan recently received a lot of attention after the bZx DeFi hack . Utilizing Ethereum’s smart contract, users can borrow all the desired amount without credit or collateral, then use the loan, and finally repay the loan. All 3 steps above are bundled in one transaction, so if the loan cannot be returned, the use of the previous loan will not be successful. You can read more here .

5.6. Liquidation

For those who are more tech savvy, there are still many other opportunities in the DeFi ecosystem such as Liquidator (liquidator). Liquidator will run a bot to identify the debts with collateral value below the specified level, then liquidate them to pay interest to the lender and receive a service fee.

6. What is the future of crypto-lending?

It can be seen that the key point of crypto lending lies in the liquidation of cryptocurrencies as collateral. Unlike traditional models, liquidating assets such as houses and vehicles with low liquidity is a long and difficult process. In contrast, with electronic money, this is very fast in just a few seconds, turning crypto lending into a potential market for profit, although there are still some limitations.


Share the news now

Source : Viblo